Upbeat Reserve testimony drives dollar higher

The Reserve Bank governor Glenn Stevens has pushed the Australian dollar half a cent higher with his most upbeat commentary in months.

Appearing before the Federal Parliament's House of Representatives Standing Committee on Economics in Canberra, Mr Stevens declared three significant global shifts over the last six months that indicate the world economy may be on the road to recovery.

"First, the threat perceived in the middle of last year of extreme financial instability arising in the euro area - and, in the eyes of some, possible disintegration of the euro - has abated. This followed various important steps taken by European policymakers," he told the committee.

"Second ... Some of the headwinds for the US economy are subsiding - the housing market seems to have turned, for example. There are still some key decision points in the fiscal area ahead but, if they can be satisfactorily managed, the US has as good a chance of delivering an upside surprise as a downside one over the period ahead.

"Third, the slowdown in China's economy has come to an end. The medium-term outlook for China is for a less hectic pace of growth than we saw on average over the past decade, and with more attention paid to the various risks - financial and environmental included - associated with that growth. Having said that, the greater absolute size of the Chinese economy now means that even less hectic growth is still of global significance and of importance to Australia."

Mr Stevens pointed out to the committee members that, even though Australia's terms of trade are down by around 17 per cent from their "exceptional peak" in mid-2011 and are likely to ease further, they are still expected to remain more than 50 per cent above their 20th century average.

That means national income is likely to remain relatively high, with exports continuing to attract relatively good prices compared to imports.

Mr Stevens was also more upbeat that many economic commentators about the peak of resource investment, emphasising that the pinnacle, while near, is very high, and downplaying the size of the drag on growth as that investment stops increasing.

"It appears that the peak in the level of resource sector investment is now close. It is a very high peak, but we do not think that there will be a rapid decline in the near term after the peak," he told the committee.

"However, it seems pretty clear that this type of investment will not be adding to demand for much longer."

The Reserve Bank governor acknowledged that business investment in other areas was not yet strong enough to pick up the slack from the fall in mining investment, however he was more optimistic about the prospects for household consumption and residential building and construction.

"Our expectation is that consumer demand will record growth roughly in line with the trend rise in income over the period ahead," Mr Stevens said.

"Housing investment should strengthen given that several factors are supportive - interest rates are low, housing prices are tending to rise, gross rental yields have increased, population growth remains strong and is even picking up a little."

Reducing rate expectations

The Reserve Bank boss also appeared to hose down expectations of further interest rate cuts.

Mr Stevens says the bank stands ready to cut further if economic data suggests it is needed, but spent some time emphasising how low both the cash rate and lending rates currently are.

"The cash rate has been reduced six times over the past 16 months, for a total decline of 175 basis points," he said.

"Allowing for some change in the gap between the cash rate and other rates, lending rates nonetheless have fallen to be not far from their historic lows."

Mr Stevens also observed that interest rates on safer investments, such as deposits and bonds, were also now at very low levels and starting to drive investors towards shares and property - a further sign that low interest rates are affecting the economy as might be expected.

However, one area where interest rate cuts have not affected the economy or financial markets is the exchange rate, with the Australian dollar virtually unchanged after the string of official interest rate cuts since late 2011.

Mr Stevens again repeated that the strength of the Australian dollar was somewhat surprising, saying it was probably a little bit high than it should be.

"It is somewhat overvalued, though we're not talking huge amounts," he responded to a committee member's question.

"The evidence of history is that if it is overvalued by a long way it's going to come down sooner or later, and the market will bring it down."

However, the RBA governor says the exchange rate has been factored into the RBA's rates decisions so far.

"This has been a relevant factor in the setting of interest rates. It is not that interest rates are seeking a particular exchange rate response, but they are being set with a recognition of the exchange rate's effect on the economy," he said.

If Mr Stevens would like a lower exchange rate, he probably should have kept mum on his positive views about the global economy and relatively rosy take on Australia's outlook.

The Australian dollar climbed around half a cent to 102.9 US cents by 10:44am (AEDT), after Mr Stevens delivered his opening statement to the committee, on increased speculation that the rate cutting cycle may have come to an end.